The high-stakes fight for your friends

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(Fortune Magazine) -- Let's try an experiment. Like most people these days, you've probably spent too much time in front of your computer today. So, quick -- name three brands you saw in online display ads within the past 24 hours.

Too hard? Then try this: Name three you saw in the past week, or month, or six months. Can't do it? You've just put your finger on the biggest problem facing the emerging digital-advertising industry. It's one that Jeff Zucker, CEO of NBC Universal (Charts, Fortune 500), has said keeps him up at night. And it's the one that Facebook and Google (Charts, Fortune 500), the David and Goliath of the World Wide Web, set out to solve in a pair of highly hyped briefings within days of each other.

The briefings -- one for Silicon Valley reporters, the other for a roomful of pinstriped ad execs not far from Madison Avenue -- set the stage for what is shaping up as the first great battle for the future of advertising on the web. The stakes are high: Up for grabs are not only ad buys worth tens of billions of dollars a year but also the very model that will control the web-ad business itself.

While the Internet has vacuumed the value out of all manner of industries from music to retail, none has been sucked drier than ad-supported media, where consumers increasingly expect to get everything free. Sponsored ads are the last revenue stream in a world where readers and viewers no longer want to subscribe. Yet while money has been pouring out of print and TV and into online advertising -- a $21.4 billion business expected to double by 2011 -- there's scant evidence that those online ads are finding their mark.

Google may be the exception. It specializes in search ads -- those little text boxes that pop up and recommend Kauai vacation packages when you Google, say, "Hawaii vacation." Search ads account for some 40% of online advertising, but they work. They drive revenue -- Google's search ads deliver click-through rates just over 5%, according to Nielsen Online, compared with rates of 0.2% for online ads in general -- and they are the main reason Google's market cap is a dizzying $219 billion.

It's the other 60% of online ads -- classified and banner ads -- that are the problem. There's hardly any money in classifieds anymore. Craigslist seems to have cornered that market, and it offers them free, much to the consternation of local newspapers. And so-called brand ads -- blinking banners across the top of the screen and the like -- are irritants most users train themselves to ignore.

Imagine, then, what an online entity that commands the attention of tens of millions of users -- say, Google or Facebook -- could do if it managed to transform brand advertising from a nuisance to something people actually could use -- or, God forbid, actually like. Facebook was the first to try to crack the problem.

The tale of how Mark Zuckerberg launched Facebook while an undergrad at Harvard and grew it into a business valued at $15 billion is already a bedtime story for Silicon Valley toddlers. What matters to advertisers, though, is that he has created a self-contained universe -- a "walled garden," in the jargon of the trade -- that now encompasses 50 million people.

Facebook users happily offer up priceless demographic data on their home pages: name, birth date, gender, marital status, political orientation. Best of all, the network encourages friends and acquaintances to form links and stay apprised of one another's activities through a "news feed" -- a kind of personal wire service that lets you track the updates your friends are making to their pages.

That is the network that Zuckerberg has opened up for advertisers with his new service, Facebook Ads. Now, whenever Facebook users rent movies at Blockbuster.com (Charts, Fortune 500), say, they are asked whether that information can be shared with their friends. If they click yes, their friends' news feeds will receive that information, sometimes with a word from the sponsor. (The sponsor pays Facebook for the privilege of placing those ads and for access to Facebook user data; sponsors also get a free home page like any other Facebook member.)

Zuckerberg distilled his presentations into this pitch: "Nothing influences a person more," he said, "than a recommendation from a trusted friend."

Zuckerberg also briefed executives at Microsoft (Charts, Fortune 500) on his plan earlier this year; it presumably figured into Bill Gates and Steve Ballmer's decision to take a 1.6% stake in Facebook for $240 million. And Zuckerberg was set to brief the advertising community when Google swept in.

Google is a laggard in social networking. It has its own site, called Orkut, which is big in Brazil and India but hasn't caught on here. So a week before Facebook's ad debut, Google unveiled a competing alliance of social networks -- an unwalled garden in which everybody but Facebook was invited to play. Google pulled together all the other big social networks -- including MySpace (Charts, Fortune 500), LinkedIn, Ning, and its own Orkut -- representing a population of 200 million, four times the size of Facebook. It named the consortium OpenSocial.

An ad strategy is still to come, but what Google did was offer its partners an opportunity to do on the wide-open web what Facebook does within its walled garden. To do that, though, it first had to win the hearts and minds of the third-party programmers who played a key role in Facebook's breakaway success.

One of the smartest things Zuckerberg did when he repositioned Facebook from a college-dorm service to a nationwide network was to open it up to software developers, inviting them to write little programs, or applications, and share in whatever revenue they could generate.

Two early Facebook developers, twins Ali and Hadi Partovi, launched a modest music-referral application called iLike in May and watched as 10,000 people signed up for it within three hours. Six months later iLike has ten million Facebook users almost entirely through word of mouth; people heard about it through friends' news feeds.

But applications such as iLike won't run on other social networks. Google's answer to that was to create a run-anywhere platform and give it away to those same developers -- sharing the same kind of data that Facebook does.

So the battle lines have been drawn. Who will win? Google may be bigger, but Facebook has the speed of the upstart. Google is still formulating its plans for social ads, whereas 100,000 advertiser pages went up on Facebook the night after Zuckerberg unveiled Facebook Ads. Facebook users can now "fan" Coke, Sony (Charts), and Verizon and interact with the brands' pages.

It's too early to say whether they'll actually do that -- or whether any of this will succeed. For its part, the ad community has embraced Facebook's plan. Sean Finnegan, CEO of Omnicom Media Group Digital, called it "a groundbreaking step toward associating word of mouth -- the best medium ever -- into the advertising space."

But aggressive ads could drive away users; one ad executive at the Facebook launch remarked that Zuckerberg's plan sounded like "spamming your friends." (Responding to a similar question during a press briefing, Zuckerberg was unapologetic: "It's an ad-supported business.")

Privacy could be a concern too. Although users can opt out of sharing news of their activities with friends, one can imagine how a hastily purchased X-rated movie could slip through.

Some developers are less than thrilled. Jia Shen, co-founder of RockYou, one of the largest widget makers on Facebook, worries that "the new types of news feeds, placements, and pages do begin to dilute the Facebook news feed."

Perhaps that's one reason developers are hedging their bets. The Partovi brothers, for example, are already working on a version of iLike for OpenSocial. They remain agnostic, choosing to work with both David and Goliath until a winner becomes apparent. "A great platform," says Ali, "is all about leaving enough money on the table."

Lindsay Blakely contributed to this article.